Certifications

Reviewing Pundits

June 28, 2013

In the flood of news, it is easy to miss the very best stories. In my regular Weighing the Week Ahead series I include plenty of links to great sources. Sometimes there are other items that deserve special attention. This weekend I recommend that you settle back with some popcorn and enjoy these three videos.

In each case you will get some very solid stock ideas from a great source. You will also learn a common theme, understood only by a few market experts. Let us take the stories one by one, and summarize the theme in the conclusion.

John Calamos

John runs the (very) largest investment firm in Naperville, our town. His office -- now a building -- is a few blocks down the street from ours, and his assets a few zeroes higher. I take a special interest in following his commentary. I sometimes think that viewers might be giving him short shrift when compared to the slick guys from New York. Someone told me that we midwesterners have an accent! Really? It sounds normal to me, and you should not let it deceive you. John's success comes from a great team and good stock selection.

He has great ideas for stocks that will benefit from rising rates, including some technology ideas! Watch the interview for more.

Ron Baron

CNBC's Squawk Box featured an extended interview with one of the leading fund managers and stock pickers, Ron Baron.

This interview is loaded with help for the individual investor, including great ideas about which companies have enduring business models. Here are some key bullet points:

Very few succeed by trading the news!

The average person who invests in mutual funds makes 3% compounded. The average mutual fund makes 7% compounded. People think they are George Soros. So wrong.

The stock market has been through a difficult 14-year period of time. It is up 1-2% a year since 1999 while earnings have doubled. It started at very over-valued levels.

Stocks are currently trading at median P/E ratios when interest rates have never been lower.

Responding to a challenge from Doug Kass via email -- Given the secular headwinds to economic growth, why should stock multiples hold up?

6.8% a year since 1960 is the growth rate of the economy. For the last 14 years it has been 4.4% and it is accelerating. People talk about 2% growth but you have to consider inflation. When you had stocks at 15 times earnings for 100 years you did not have interest rates at zero. Look at the comparison. Businesses are growing and growing faster. Money is cheap. Businesses are attractively valued. When the economy grew at 6.8% stocks were growing by 6.1% plus you have to add dividends which makes it about 8%. That's for 120 years. Will it keep up at that rate? Maybe it will be a little less. We are using 7%. That means a double in 10 years -- 30K in ten years and 60K in 20 years.

Robbins is described by CNBC as a "hedge fund titan" who rarely does interviews. Since I regularly hear misleading information from managers with high AUM's, I prefer to decide for myself when it comes to credentials.

Robbins demonstrated a special insight in the health and health management fields. This is a great sector to study with plenty of cross-currents. We have the demographic effects from an aging population and also the influence of ObamaCare. We still do not know how the new policies will be implemented or which states will participate.

All three sources demonstrated a very sophisticated understanding of the relationship between stocks and interest rates. They all note that stock market multiples are actually strongest when interest rates are in the range of four percent.

Baron emphasizes the importance of stocks in fighting inflation.

Robbins notes the multiple, stating "When interest rates are between 3 and 7 percent, the long-term history
of the market is to trade between 17 and 18 times earnings. With our
portfolio trading at 10 1/2, we'll take our chances."

Calamos notes, "...if you go back even 50,60 years, when the 10-year bondwas 4% to 6%, p/es were 20,which means it's a much moregrowth environment.so i think we have to, you know,re-educate investors that, youknow, going back to normal ratesis not a bad thing."

Most traders and pundits, as usual, have an overly simplistic rule linking interest rates and stocks. Higher rates are worse. The loudest voices telling stock investors to worry about ten-year yields moving higher from two percent said the opposite when rates were moving down to two percent. On the way down, it was a sign of economic weakness. And now, on the way up.....?

For those who prefer data to speculation, please check out my "Scared Witless" (TM OldProf euphemism) post. I describe a "final destination" where a four percent ten-year yield is something of a sweet spot for stocks.

At the start of the week we saw the knee-jerk reaction to higher interest rates. Eventually, the normal relationships will return. It provides an opportunity for those in the know.

March 06, 2013

This month's report is especially important. I am cautious for several reasons:

The market rally is generally perceived as extended – many are looking for a reason to sell;

The story is complex, with many spinning angles;

There is a ceiling on strength, due to incorrect assumptions about the Fed.

I will elaborate in the conclusion, but let us first review the expectations for Friday's report.

Background

For many years I have written a regular monthly preview of the Employment Situation Report. I have done extensive research on all of the methods and even visited the stat guys at the BLS to discuss their approach.

My preview gives appropriate respect to the BLS, but also to the leading alternative methods. My best analogy was to a bean-counting contest. The winner was NOT the contestant who was closest to the correct answer. Instead, the winner had to predict the guess of a fellow contestant.

This is what we do every month. We want to know the truth about the economy. Instead of recognizing that there are several good estimates, everyone tries to guess what the BLS will report.

Last month I did something extra, reviewing the most recent period for which we have actual data and showing who had the best estimate. There were three conclusions:

All of the estimates were too low.

The much-maligned ADP was the best, and that missed by more than 100K jobs.

The BLS methods were the worst.

We rely too much on the monthly employment report. It is a natural mistake. We all want to know whether the economy is improving and, if so, by how much. Employment is the key metric since it is fundamental for consumption, corporate profits, tax revenues, deficit reduction, and financial markets. Whenever there is an important question, we all seize on any available information. While we might know the limitations of the data, any concern is briefly acknowledged -- if at all -- and then swiftly put aside.

The Data

We would like to know the net addition of jobs in the month of February.

To provide an estimate of monthly job changes the BLS has a complex methodology that includes the following steps:

An initial report of a survey of establishments. Even if the survey sample was perfect (and we all know that it is not) and the response rate was 100% (which it is not) the sampling error alone for a 90% confidence interval is +/- 100K jobs.

The report is revised to reflect additional responses over the next two months. This is especially important this month since the official survey response date has been moved forward by a week. This is a routine adjustment for the Thanksgiving holiday, but it increases the potential for error and later revision.

There is an adjustment to account for job creation -- much maligned and misunderstood by nearly everyone. Everyone focuses on the birth/death adjustment. This actually accounts for less than 20% of the BLS attempt to estimate job creation.

The final data are benchmarked against the state employment data every year. This usually shows that the overall process was very good, but it led to major downward adjustments at the time of the recession. More recently, the BLS estimates have been too low, as revealed in the most recent report. For the year ending in March, 2012, the BLS estimate was off by about 30K jobs per month overall, and 35k jobs per month on private employment. The January report adjusted for these benchmark revisions.

Competing Estimates

The BLS report is really an initial estimate, not the ultimate answer. The BLS is actually like one of the contestants, with the full report coming later. The market uses this estimate as "official" and declares winners and losers on that basis. No one pays any attention to the final data, which we do not see for eight months or so.

ADP has actual, real-time data from firms that use their services. The firms are not completely representative of the entire universe, but it is a different and interesting source. ADP reports gains of 198K private jobs on a seasonally adjusted basis. In general, the ADP results correlate well with the final data from the BLS, but not always the initial estimate. In recent months ADP is using an improved methodology with a stronger sample. The objective is to improve the correlation with the final print of the employment data.

TrimTabs looks at income tax withholding data. Their idea is that this is the best current method for determining real job growth. TrimTabs forecasts a gain of 100K. There was a lot of year-end uncertainty about tax law from the fiscal cliff debate. TrimTabs has wisely taken note of this and is trying to adjust for the changes in tax withholding.

Economic correlations. Most Wall Street economists use a method that employs data from various inputs, sometimes including ADP (which I think is cheating -- you should make an independent estimate).

Jeff Method. I use the four-week moving average of initial claims, the ISM manufacturing index, and the University of Michigan sentiment index. I do this to embrace both job creation (running at over 2.3 million jobs per month) and job destruction (running at about 2.1 million jobs per month). In mid-2011 the sentiment index started reflecting gas prices and the debt ceiling debate rather than broader concerns. When you know there is a problem with an input variable, you need to review the model. For the moment, the Jeff model is on the sidelines, but it is a high priority summer project. It remains difficult to account for the effect of headlines about politics, the sequestration debate, and the end of the payroll tax relief. None of these factors relates to employment, so there is more noise than signal right now. Layoffs catch the headlines, because these are big visible chunks of jobs. I do not think we have a good grasp on job creation. The BLS tries hard, but their approach lags on this front. Street estimates are generally similar to my method, but few reveal much about the specific approach. These estimates usually adjust for the ADP report.

Briefing.comcites the consensus estimate as 178K, while their own forecast is for 180K. Their private jobs forecast is about 15-20K higher, since the loss of public jobs is a continuing drag.

Gallup does not seem to have an update to their unemployment series. I have tried to give this source respect and equal time despite a rather overt bearish and political approach in past commentaries. Why no update on seasonally adjusted unemployment?

Failures of Understanding

There is a list of repeated monthly mistakes by the assembled jobs punditry:

Focus on net job creation. This is the most important. The big story is the teeming stew of job gains and losses. It is never mentioned on employment Friday. The US economy creates over 7 million jobs every quarter.

Failure to recognize sampling error. The payroll number has a confidence interval of +/- 105K jobs. The household survey is +/- 450K jobs. We take small deviations from expectations too seriously -- far too seriously.

False emphasis on "the internals." Pundits pontificate on various sub-categories of the report, assuming laser-like accuracy. In fact, the sampling error (not to mention revisions and non-sampling error) in these categories is huge.

Negative spin on the BLS methods. There is a routine monthly question about how many payroll jobs were added by the BLS birth/death adjustment. This is a propaganda war that seems to have ended years ago with a huge bearish spin. For anyone who really wants to know, the BLS methods have been under-estimating new job creation. This will be reflected in the January report, which will show over 350K additional jobs in the benchmark year.

It would be a refreshing change if your top news sources featured any of these ideas, but don't hold your breath!

And most importantly, it would be helpful if anyone would realize that the BLS is just one estimate among others -- and perhaps not the best. The bean counter example illustrates this.

Trading Implications

In my experience it has usually been safe to be conservative in front of this report. The story is so complex that it is pretty easy to generate a negative spin. Your favorite perma-bear/conspiracy site does a good job of preparing. It is poised to comment on seasonal adjustment, birth/death adjustment, labor force participation, hours worked, and discrepancies between the payroll and household surveys.

Here is an experiment. Check out what they say right after the number is reported and also note Rick Santelli's initial reaction on CNBC. Then follow Santelli for the next 30 minutes. He will get the message and report it.

Some might think of it as the "Santelli call" which would be the opposite of the "Bernanke put." It might only work for a few minutes, but that is long enough for shorts to cover.

I am also concerned about the ISM reports. While these have been very strong, the employment components have been weaker.

Here are some fearless forecasts from the Old Prof:

Much will be made of seasonal adjustments - - mostly by those who have never produced a dataset that included any seasonal adjusting!

No one will recognize that the BLS estimate is just that --- an estimate. We already know most of the answer, and it is pretty good.

Any extreme result will get an exaggerated interpretation. If the job growth were to be 50K, we will have claims that recession is upon us. If the BLS estimate is 300K, we will hear that the Fed is about to tighten rates!

Watch the "hours worked." This could be an early indicator of employment weakness.

As usual, the number is less important than everyone thinks. So here is the most important point:

The Fed will not change policy based upon the February employment report—no matter the outcome. Everything that I have written here is completely understood by the FOMC. It will take a long series of results to influence Fed policy. Since traders and pundits do not seem to grasp this, the wise investor may get (yet another) opportunity.

January 21, 2013

Since no one seems to take Latin any more, you probably cannot translate "ceteris paribus."

Real economists frequently cite the need to explicitly state the assumption that "all other things are equal."

In the blogging world, the biggest voices on economics are not economists. This should not surprise us. The pop economists are playing to our vision of reality:

State what the reader already believes;

Provide data that appears to support the belief; and

Add some bogus conclusion.

It happens every day.

Background

I am going to reveal something personal and unprofessorial. I like Jack Reacher – the character, the strength, the simplicity of needs, the moral compass, and of course, the ability to "connect."

Like many others, I was interested in the upcoming movie. How could Tom Cruise portray this giant? In reading about the story I discovered something interesting about investments. Lee Child is a pseudonym and the Brit who is actually writing is a guy named "Jim Grant." No, not that one!

Although he'd never lived in the U.S., Grant had visited frequently, had lapped up American TV, and had even married an American woman. "It was really a question of mimicking," he says. "If you're familiar with the rhythms and the word choices of the country and you can put them down on paper, it actually becomes their nationality." British drollery metamorphosed into a kind of hypnotic, Eastwoodian growl. Killing Floor, the first Reacher book, opens like this:

I was arrested in Eno's diner. At twelve o'clock. I was eating eggs and drinking coffee. A late breakfast, not lunch. I was wet and tired after a long walk in heavy rain. All the way from the highway to the edge of town.

Grant's wife, Jane, read his drafts and clipped out Britishisms. She called herself the Committee on Un-American Activities.

The Americanness of Lee Child's novels did not come from granular detail, from a novelistic sense of place. "You know you're in Nebraska because he says, 'We're in Nebraska,'" notes Otto Penzler, the owner of New York's Mysterious Bookshop. "You don't smell the cornfields."

No, Child aims to deliver a different American vision. When Reacher goes to Nebraska, as he did in Worth Dying For, Child borrows images from movies and TV shows — it's a "Nebraska" of our collective imagination. As Child puts it, "If you stick to that mental image, everybody says, 'That's a well-researched book.' If you actually supply the reality, people say, 'The guy's never been there.'" It's as if Child is feeding back to us the images America once beamed to England.

Investment Implications

Bringing this back to the world of investments there is a clear conclusion:

The great novelist of thrillers reveals the technique of the great fiction writers of economics!

They are telling you what you think you already know – not trying to inform.

Spotting These Imposters

The biggest tipoff to the pop economist is when he/she does not say, "ceteris paribus." This means that the author is trying to change only a single variable in a multivariate world – an amateur approach.

Here are two current examples:

Profit margins. We have all heard ad nauseam that profit margins are mean-reverting. The blunder of this one-variable approach is a failure to consider why profit margins are so high. Corporations have squeezed employment and costs. Think lean and mean. Those taking this viewpoint have been wrong and the multivariate approach which I endorsed two years ago and again last year has been correct. Profit margins will decline if and only if there is a massive increase in revenue and gross earnings. There is still time for investors to grasp this concept, since the wrong-headed bearish viewpoint prevails.

Interest rates. Suppose interest rates were to move higher, forcing greater government expenditures and offering a more attractive alternative to stocks. The Fed might go broke! I need to write more on this theme, but the concept is the same. The Fed is actively trying to increase inflation expectations. They want to encourage investment. That is the plan, little understood by traders. So there is no "ceteris paribus." When interest rates rise, the move will be accompanied by a vigorous economic rebound, including business and consumer investment.

Only the pop economists isolate on one variable and project the worst case.

December 12, 2012

Anyone who made it through college remembers "Cliff Notes." As a professor, one of my jobs was to identify students who had read the real work. Who were the imposters?

Now I am on the dark side!

Investors can join me with our Fiscal Cliff Notes. There are so many pretenders, and so little real information.

I have repeatedly warned that the entire discussion is a costly distraction for most investors. Here are the leading characters in the noise game:

The TV Anchors. Sports fans see this constantly. If you are a sportscaster or "color man" you need to keep talking, no matter what is happening. It is a demanding job, leading to a lot of stupid commentary. One of my favorite sports websites is Awful Announcing, where viewers and readers send in their favorite nominations for the blooper of the week. With the massive and excessive coverage of the Fiscal Cliff, it is easy to find the blooper of the hour. (Examples below).

The Pseudo-Experts. Someone who knows absolutely nothing about what is happening makes a statement. If the prediction is dramatic, it gets attention.

The Former Star player. Someone who used to have power, and wants to maintain the image.

The Wannabee. Often someone without any special knowledge or credentials who wants to seem important.

Bad Commentary

Here are some typical examples of poor commentary. I could give (multiple) citations for each, but that is not the point. If you are a journalist or TV anchor, you have a need for content. Standards decline. Readers are invited to offer more in the comments.

Breathlessly reporting every public statement. This is silly. The real negotiations are not happening in public and the statements are not really news.

Calling the participants "kindergartners" (or worse). This sort of opinionated commentary simply shows a complete lack of understanding of the process. It has become a staple at CNBC, where they are on 24/7 cliff watch. No doubt they will claim credit when it is all over.

Most of the public affairs news shows. Normally the Sunday morning shows are helpful. I record and watch several of them every week. This week we got to see a posturing Newt Gingrich, who made dramatic statements. It was obvious that he was not in touch with what was really happening. The group on ABC included a lecture from Paul Krugman and a responding attack on Krugman's motives from George Will. There was a disappointing lack of substance, mostly because the panel had no real information.

The claim that the market expects a resolution, and has priced it in. With more than half of the public expecting us to go over the cliff, a parade of TV pundits saying the same thing, and the anchors themselves emphasizing this conclusion -- it should be obvious. The issue is in doubt. Whenever this is the case, the market will move one way or the other on the outcome.

The message should be clear: You cannot infer progress, lack of progress, or substance from any of these public statements. What a delight! You can ignore the news and just read the Cliff notes.

Real Information

If you want real information about progress, you need to look at unsourced reports from behind the scenes. These paint a very different picture:

There is actual movement toward a compromise. On the key tax issue, President Obama will relax the rate on the rich by a bit and the GOP will allow some rate increase on high-income taxpayers. The key threshold might move from $250,000 to $500,000.

There will be a solution on the tax issues before year's end. There is tremendous pressure for this on Republicans. No one wants an ambiguous tax code going into the new year, and the main impacts are on GOP constituents.

Participants are trying for a pre-Christmas solution, but there are no guarantees. It might drift for another week.

Explanations

Any fair-minded people who use their business experience and general intelligence can understand the dynamics of the political process, even if they did not take my course in Poli Sci 101. (One of my best teaching experiences was the standing "O" I got at the end of this class in my first semester. It was a real inspiration for a young new Asst. Prof).

Deadlines. Going down to the wire is typical in business. It happens in labor negotiations, corporate buyouts, and new product introductions. It is not the stuff of kindergarten, but rather what happens in the real world.

Significance. These decisions will set the national course for many years to come. They will be difficult to change. It is important to get it right.

Publicity. While the election is over, public support is still relevant to negotiating at the margins. This is reality, and it occurs in labor/management issues as well.

Opportunity. The most popular government programs cut taxes or increase benefits. The most difficult decisions do the opposite. A lame-duck session of Congress is as far removed from politics as we can get. There are retiring members and those with safe seats. There is no better opportunity for making big changes and grand bargains.

Conclusion

My objective is to help investors understand what is going on without the need to absorb and interpret the avalanche of information. Most of it can safely be ignored, but I'll follow up when there is relevant news.

Here is a final tip for traders: If you see a news flash about a joint announcement (Obama and a GOP rep) that is bullish. You will need to be watching and to buy quickly.

When should you sell? Perhaps as the participants go to the podium. Maybe sooner!

This year's Fiscal Cliff resolution will not be celebrated by all. More in the next "Fiscal Cliff Notes."

October 02, 2012

The analysis of current Fed policy has included the usual parade of mistaken pundits.

There is a legitimate debate about QE3, but it has been obscured by those with an agenda based upon their politics or their business models.

The result is an exceptional opportunity for the long-term investor.

Mistakes

Here are the four biggest mistakes:

It's all about me! This is how the investment community views both the policy and every communication from the Fed. What a blunder! They look only at the effect on stocks. The Fed mentions stock market effects, but only as one of several indicators. They see the market as a confirmation that their moves either have helped the economy or are expected to do so.

I don't understand the mechanism, so it must be wrong. The typical pundit asks questions like the following:

Suppose a home-buyer does not qualify for a loan. How will this change that?

Mr. Gundlach (or Gross or some other bond guy), How will this change your behavior?

How can this create jobs? I don't see how to connect the dots.

This is just printing money and monetizing the debt since the Fed is buying X% of new mortgages, etc.

There is no exit strategy. When the time comes to reverse course, we will have a disaster.

Reality

And here are the correct answers, pretty obvious to anyone with any training in economics:

The basic objective is to change behavior on the part of borrowers and lenders. The stock market is only one method for evaluating the impact and the "wealth" effect is only a minor transmission mechanism.

The key to understanding QE3 is to think about marginal effects, not the all-or-nothing, "light-switch" thinking of those without economic education. If you lower the price of something, it has a marginal effect. Lower interest rates encourage more borrowers, qualify more borrowers, and increase the size of qualified loans. The price changes affect (marginally) the interest rates on all related bonds. The increased Fed balance sheet creates more excess reserves for banks and nudges them toward more lending. Lower rates make business investments slightly more attractive. This all takes place at the margin. This is the incentive for risk that Bernanke talks about. None of it has anything to do with pushing the average investor into risk assets, the popular pundit theme.

The Fed is not monetizing debt if the purchases of securities are temporary. The concept of "printing money" should relate to an increase in the money supply -- M2 or MZM. These increases have been modest -- too low in fact. The hyper-inflationistas have been wrong for a decade or so, but that does not stop their chorus.

Reversing course depends upon the demand for US debt, both Treasuries and Agency securities. Readers should note that those who have questioned this theme in the past, asking who will buy our debt at the end of prior QE's have been completely wrong. I do not understand why Bill Gross could be so mistaken, but he was. He does not seem to distinguish between the total volume of US Treasury trading and the net issuance. Or maybe he has his own agenda. Meanwhile, the average investor does not understand the total volume of Treasury trading. (See this piece for an illustration).

Quantifying the Effects

There are some solid econometric efforts to quantify the QE3 effects. Here is a Bloomberg article that is helpful by sharing some results:

"In a model-driven assessment based on the past impact of QE1 and QE2,
Deutsche Bank Securities chief economist Peter Hooper says this is what
the Federal Reserve printing another $800 billion — slightly less than
the gross domestic product of Australia — will do:

1. Reduce the 10-year Treasury yield by 51 bps

2. Raise the level of real GDP by 0.64%

3. Lower the unemployment rate by 0.32 percentage points

4. Increase house prices by 1.82%

5. Boost the S&P 500 by 3.06%, and

6. Raise inflation expectations by 0.25%"

I am disappointed that the writer diminished his helpfulness by skewing in such a skeptical direction about these findings, falling into the basic current trap of catering to his audience.

The Deutsche Bank conclusion is correct. The general direction and order of magnitude of these effects makes sense given past QE policies.

A Deeper Look

In fact, I expect the current QE round to be more effective than the past versions. Why? The focus on changing expectations.

In the past, any good economic news was greeted with the notion that the Fed would step back. The current policy changes this. The Fed is committed to economic stimulation, even if it pushes inflation somewhat above the 2% target level.

For those who don't like the the Fed inflation measurement methods, you can just multiply by ten or apply whatever other silly adjustment you think is right. Meanwhile -- learn to live with it! This is the new policy.

Investment Implications

The basic conclusion is that the business cycle is going to be extended significantly. We are in the third inning or so. It is a good time for tech stocks and deep cyclicals. (I like and own CAT, ITW, AAPL, ORCL, and INTC).

The timing is a bit different from past QE's. Since everyone is busy misinterpreting the policy, bashing the Fed, and politicizing the decision, the immediate market impact has been muted.

This time the real test will come via the actual economy, not the speculative commodity buying of the those with a simplistic view of Fed policy. The upside catalyst will come when we see some stronger economic reports, as we did with yesterday's ISM numbers.

September 17, 2012

Sometimes looking ahead includes understanding what has just happened. The coming week will emphasize housing news, but it will also include a continuing debate on the dramatic changes in policy both in the US and Europe.

Economic prospects improved greatly last week. Key policymakers have geared up to fight deflation and a potential liquidity trap.

For those of us who put aside our preferences about the upcoming election, focusing instead on the economy, the answer is clear. There is an active debate in the economic community, among those who have knowledge, analytical skill, and data. The Fed decision reflects that.

The investment community sees a different and wrongly-focused picture. It is one that has been costly in the past, and will continue to be so. This is because they rely on a bogus perception of Fed policy, something I emphasized last week. Anyone who paid attention was on the right side of the market last week, and will have a better understanding in the future.

There is not much mystery about predicting Fed moves and the market results, but it does require objectivity.

Implications for Housing

Savvy market followers are already watching the improving trends in housing. Bill McBride at Calculated Risk was bearish and authoritative on housing at the right time and for the right reasons. He earned the respect of the entire economic community and expanded his coverage aggressively and extensively. Readers of "A Dash" should set aside an hour or so to go through the archives at Calculated Risk, emphasizing the 2012 take on housing.

You will find the analysis both cogent and convincing. Your hour will be well-spent and profitable.

I'll offer some of my own expectations in the conclusion, but first let us do our regular review of last week's news.

Background on "Weighing the Week Ahead"

There
are many good sources for a list of upcoming events. One source I
especially like is the weekly post from the WSJ's Market Beat blog.

In
contrast, I highlight a smaller group of events. My theme is an
expert guess about what we will be watching on TV and reading in
the mainstream media. It is a focus on what I think is important
for my trading and client portfolios.

This is unlike my
other articles at "A Dash" where I develop a focused, logical
argument with supporting data on a single theme. Here I am simply
sharing my conclusions. Sometimes these are topics that I have
already written about, and others are on my agenda. I am putting
the news in context.

Readers often disagree with my
conclusions. Do not be bashful. Join in and comment about what we
should expect in the days ahead. This weekly piece emphasizes my
opinions about what is really important and how to put the news in
context. I have had great success with my approach, but feel free
to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is
"ugly" and on rare occasion something really good.
My working definition of "good" has two
components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.

It is better than expectations.

The Good

The news last week was very good, even better than the market result.

The new Fed policy is market-friendly in many ways. The additional investment of $40B per month in MBS securities is fresh and "unsterilized" buying. The focus on housing is constructive. Most importantly, the policy is open-ended, dependent on results rather than time. It cannot be gamed by traders or pundits.

The German Constitutional Court delivered as expected. This sets the framework for more aggressive banking rules in Europe. It was a crucial step in the incremental process for a Eurozone solution. Those who do not see this are in denial over their incorrect forecasts. Italian and Spanish bond yields have moved dramatically lower. Italy might not even need a further bailout (via Reuters).

Michigan consumer sentiment showed surprising strength. This is good news for employment and for consumer spending, especially since gas prices have been higher. Doug Short's chart captures the long-term patter, showing that we are back to the recent highs.

Technical indicators remain positive according to Charles Kirk. One advantage of writing after my usual Saturday time is that I can include Kirk's weekly chart show, usually published on Sunday. I always read Charles and you should, too (small subscription required, and well worth it). The short message this week is that there is nothing yet to indicate that the rally is in jeopardy.

Initial jobless claims popped to 382,000. Seasonal factors are cited, once again, but this should be recognized as bad news.

Sea container counts are lower (via Steven Hansen). This is a good concurrent indicator.

Industrial production declined by 1.2%, the worst since the start of the recession. Since this is part of the NBER's group of recession indicators, we watch it closely. The best source is Doug Short's "Big Four" update. Here is the most recent chart:

The Ugly

The ugliest news this week related to the death of US Ambassador to Libya, J. Christopher Stevens. The story has many dimensions and dominated today's news programs. A real analysis is beyond what we can do in the weekly column, but it certainly represents a topic we should all be watching.

The underlying issues involve freedom of speech, security at embassies, foreign aid, and the US image abroad. The consequences affect oil prices, trade issues, and even nuclear flashpoints.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up
an unpopular or thankless cause, doing the real work to demonstrate
the facts. Think of The Lone Ranger.

This week's award goes to Bob McTeer, although his entry is modestly stated. The problem is that he is a frequent guest on Larry Kudlow's show. Kudlow has skewed to an almost unwatchable level of political commentary (so sad for me, one of his most loyal viewers). McTeer is a rock-ribbed Republican, and a genteel and gracious person.

Kudlow said something that is very foolish, but sounds good to the average viewer. McTeer calls him on it, but without naming the source. I already had the Kudlow statement on my own blog agenda, so this saves me the work of a post. Meanwhile, does McTeer deserve full honors when he will not name the source?

Here is the point. Kudlow notes that the Fed claims to have created two million jobs while increasing the balance sheet by $2 trillion. This is a frequent blunder by critics of government policy, who ignore what the expenditure has purchased. Here is McTeer's response:

"The arithmetic may be right, but the logic is wrong. The “spending”
may have been motivated by the need to unfreeze credit markets and
stimulate the economy and create jobs, but the spending was on Treasury
securities, mortgage-backed securities, commercial paper and the
like—assets that are still on the Fed’s balance sheet if they haven’t
matured and been replaced. Those assets did not disappear. They can be
sold or held to maturity. Meanwhile, they produce earnings which
increase the amounts turned over to the Treasury by the Fed. Taxpayer
funds have not been used; they have been augmented.

To repeat for emphasis, however many jobs the $2 trillion may have helped “buy,” it also bought $2 trillion of securities."

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The SLFSI reports with a one-week lag. This means that the
reported values do not include
last week's market action. The SLFSI
has moved a lot lower, and is now out of the
trigger range of my pre-determined
risk alarm. This is an excellent tool for
managing risk objectively, and it has
suggested the need for more caution. Before
implementing this indicator our team did
extensive research, discovering a "warning
range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool,
since it does not attempt to predict how people will interpret
events. It uses data, mostly from credit markets, to reach an
objective risk assessment. The biggest profits come from
going all-in when risk is high on this indicator, but so do
the biggest losses.

Bob and I recently did some videos explaining the recession
history. I am working on a post that will show how to use this method.
As I have written for many months, there is no imminent recession
concern. I recently showed the significance of by explaining the relationship to the business cycle.

The evidence against the ECRI recession forecast continues to mount.
It is disappointing that those with the best forecasting records get
so much less media attention. The idea that a recession has already
started is losing credibility with most observers. I urge readers to
check out the list of excellent updates from prior posts.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

The single best resource for the ECRI call and the ongoing debate is Doug Short. This week's articledescribes
the complete history, the critics, and how it has played out. The post highlights the most important economic indicators used in
identifying recessions, showing that none have rolled over. Doug
updates the recession debate every week and includes a great chart of
the "big four" indicators used by the NBER in recession dating.

Meanwhile, the ECRI story continues to change. The latest variation is that the data will eventually be revised lower to show that we are already in recession. The Bloomberg interviews, which have generally been very friendly, now state,

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll.
We have a long public record for these
positions. This week we switched back to bullish after a brief stint at "neutral." These are one-month forecasts for the poll, but Felix has a
three-week horizon. The ratings have moved a little higher, and the confidence has improved from last week. It has been a close call over the last few weeks.

[For more on the penalty box see this article.
For more on the system
ratings, you can write to etf at newarc
dot com for our free report package or to
be added to the (free) weekly ETF
email list. You can also write
personally to me with questions or
comments, and I'll do my best to answer.]

The Week Ahead

There is a relatively moderate calendar for data this week.

The "A List" includes the following:

Building permits (W) which provide the best leading indicator on housing.

Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy.

The "B List" includes several reports:

Housing starts (W).

Leading economic indicators (Th) which while frequently tweaked to improve the fit, are interesting to many.

There are also the regional Fed indexes from NY and Philly. I do not regard these as very important, especially in the wake of last week's Fed decision. The market reacts when there is a big move. We also will have the Markit flash PMI reports, which are starting to earn a following.

Trading Time Frame

Despite Felix's overall "neutral" posture, our trading positions continued in fully invested mode last week.
Felix became more aggressive in a timely fashion, near the start of the
summer rally. Since we only require three buyable sectors, the
trading accounts look for the "bull market somewhere" even when the
overall picture is neutral. The ratings have been getting a little stronger, so we maintain the profitable trades.

Felix does not try to call tops and bottoms, but instead keeps us on the
right side of major moves, either up or down.

Investor Time Frame

Long-term investors face a challenge this week. They will be bombarded with comments from Fed critics, gold buffs, recessionistas, and hyper-inflation zealots. These people have all been completely wrong for years, but they are still featured as experts.

Long-term investing is an objective for
many of my clients, so I give it a lot of thought. Each week I use this space to share (right or wrong) my best long-term thoughts. Sometimes this means emphasizing themes that I have written about more comprehensively.

Here are two such thoughts.

How much risk should you take?
The right answer is different for everyone, but too many people choose
"zero." These investors do not follow the Buffett advice of buying when
others are fearful. Then, when the market rallies, they are afraid
that they are "too late." I wrote a new article, Stock Prices and the Fundamentals: Don't be Fooled, showing how to avoid this trap. The answer is not going "all in" since most of us have to pay more attention to short-term risk than does Mr. Buffett!

Should you worry about the "fiscal cliff?" The basic answer is "not yet." I explain why in two articles. The first reveals my one-word solution. The second offers my current expectations, and how I am investing for the long-term program.

If you have been following our regular advice, you have done the following:

Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and

Added some octane with a reasonable allocation of good stocks.

There is nothing more satisfying than getting yield and call premiums, even if stocks move sideways.

If you have not done so, it is certainly not too late. We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments and suggestions welcome!)

Final Thoughts on Housing

Most market followers are missing the inflection point in housing. The Fed has acted aggressively. To understand the significance of the new Fed policy would require a lot of reading. I cannot review it all in the weekly summary post, so let me suggest another key source, James Hamilton.

"I think the correct interpretation of QE3 is that the Fed has
unambiguously signaled that it's not going to re-run the Japanese
experiment to see what happens when the central bank stands by and
watches wages and prices fall even while unemployment remains very high.
The Fed can and will keep U.S. inflation from falling much below 2%,
and that may help a little. Investors should expect that, and not a
whole lot more."

The mistake that most are making is the typical one for non-economists: black and white, all or nothing.

Suppose that QE3 reduces mortgage rates by 0.125%. This translates into a purchasing power increase of about 1.5%. You cannot just tack that onto home prices, since the benefit is split. What happens is that the demand curve is shifted a little.

So ignore the clueless bozos who say things like the following:

No new buyers will qualify.

When did you last hear about someone who didn't buy because interest rates were too high?

These pontificating pundits do not understand economics, and they are probably on a mission related to their own pocketbook.

We need to think about marginal effects. A few more buyers will qualify. Those that do qualify can afford a little more house.

The subjects are so complicated, that I cannot treat them properly in the weekly summary article. I can only share my own conclusions, as always, and point you to the best sources.

(Note to readers: I took a little time off this weekend, but the topics are so important that I want to maintain continuity in the series. This is one of the most difficult articles in the entire series).

September 08, 2012

After weeks of buildup, culminating with Fed Chair Bernanke's Jackson Hole speech, the time for decision has arrived. While some of the economic data is better, the jobs picture remains poor. Friday's employment report has raised expectations for some aggressive action. Are these hopes justified, or will the Fed disappoint the markets?

I was very accurate last week in predicting that the story would be all about jobs. The Democratic Convention, the pundit commentary, the GOP response, the media focus, and the Thursday and Friday data all followed this theme. Given Friday's disappointing employment situation report, the question became, What now? I suggested in my employment preview that reaction would be dampened by the expectation of more aggressive Fed action. This is exactly what we saw from Friday's trading.

Market Background

The general expectations have shifted, setting the bar higher. Here is the take from Jon Hilsenrath, who seems to have the pulse of the Fed:

"Officials have been leaning toward an open-ended bond-buying program in
which the Fed holds open the possibility that it will continue to buy
bonds after an initial allotment is purchased if the economy doesn’t
pick up. They also have been leaning toward purchasing mortgage backed
securities."

The expectations from these sources are at odds with the investment posture of both the Street, and the public. Check out two of my favorite sources.

Barry Ritholtz has tracked the "most hated rally" so check out his article for the history. Here is the chart that shows why this is important -- the underinvestment of some big firms.

Josh Brown shows the same psychology on the part of average investors, explaining that they have left $65 billion on the table through recent decisions to bail out of stocks.

I'll offer some of my own expectations in the conclusion, but first let us do our regular review of last week's news.

Background on "Weighing the Week Ahead"

There
are many good sources for a list of upcoming events. One source I especially like is the weekly post from the WSJ's Market Beat blog. Ben Fox Rubin and Steven Russolillo go beyond the formal list of economic releases by mentioning major earnings reports, speeches, and even conferences.

In
contrast, I highlight a smaller group of events. My theme is an
expert guess about what we will be watching on TV and reading in
the mainstream media. It is a focus on what I think is important
for my trading and client portfolios.

This is unlike my
other articles at "A Dash" where I develop a focused, logical
argument with supporting data on a single theme. Here I am simply
sharing my conclusions. Sometimes these are topics that I have
already written about, and others are on my agenda. I am putting
the news in context.

Readers often disagree with my
conclusions. Do not be bashful. Join in and comment about what we
should expect in the days ahead. This weekly piece emphasizes my
opinions about what is really important and how to put the news in
context. I have had great success with my approach, but feel free
to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is
"ugly" and on rare occasion something really good.
My working definition of "good" has two
components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.

It is better than expectations.

The Good

There was a fair amount of good news last week.

The ISM services index provided an upside surprise. The employment component is especially encouraging. Bespoke has a comprehensive look with the components individually listed and charted. Here is the overall history, but the full article is worth a look.

Home prices continue to rise as measured by CoreLogic. Global Economic Intersection has an excellent discussion and charts comparing different approaches. Here is a sample:

Productivity was up 2.2%, handily beating expectations. Productivity gains have come from corporations doing more with fewer workers. At some point they will need to add workers to meet growing demand. Meanwhile, this is good news for profits.

Job creation was strong, according to ADP and various other analysts, as I described in my monthly employment report preview. I understand the need for some "official" result, and the BLS method is very good. Alternative approaches are also very good. In the richness of time, these estimates often prove to be more accurate.

The ECB delivered on promises. Unlike many of the past incremental steps in Europe, this one did not generate a "sell the news" reaction. The potential open-ended nature, the willingness to take equal status with private investment, and the assertion of power to act independently from government decisions were all factors. The one downside element was that the purchases will be "sterilized" so that the overall balance sheet does not expand. This is not the all-out money printing that some craved. The overall effect was rather amazing, stretching into the 10-year yield for Spain and Italy, even though that is not where the ECB proposed to buy. Attitudes seem to be changing, as reflected in market prices.

The Bad

There was negative news, lesser in quantity but greater in importance.

Earnings forecasts drift lower. Brian Gilmartin, an expert on earnings both for individual companies and the overall market, tracks these trends very closely. (Similarly, Dr. Ed Yardeni) He notes the recent weakness and acknowledges the debate about what is already priced into the market. On his excellent new blog he writes as follows:

"...(A)ccording to ThomsonReuters – 2nd quarter, 2012 earnings are still
expected to grow at 1.3% ( ex Bank of America and the financial sector)
and 3rd quarter, 2012 earnings, which we continue to think will be the
bottom for this cycle in terms of the earnings slowdown, are expected to
decline year-over-year at a -2.1% rate.

The forward 4-quarter estimate for the S&P 500 estimate as of late last week was $108.02, exactly where it was 1 week ago."

Economic confidence remains weak (via Gallup). This measure is off the lows from last year, but still very weak -- a bad sign for consumer spending.

Foreign economic indicators (Europe and China) all declined last week. I always watch these -- always. It is how I start my day, and I often comment on them in my daily diary at Wall Street All Stars. I understand that we have a global economy, and I want to put it in perspective. Offsetting some of the decline, China will do more stimulus. Analyzing the impact on US stocks is a challenge.

The official jobs numbers reflected a weak economy, worse than expected and worse than needed. Discussing this objectively is nearly impossible for most, since the issue is so salient for voters. There was nothing good about this report. The net job gain of 96,000 is less than needed to keep up with the growth in population (perhaps 125k, although the target changes with trends in retirement and immigration). Downward revisions for the last two months subtracted another 40K jobs, half of which were in government. The household survey also showed a decline in jobs, although this series has fluctuated wildly. The decline in the unemployment rate was not statistically significant (after rounding) and mostly reflected a reduction in the labor force.

The official employment data is roughly consistent with the rest of what we see -- growth of 2% or so. Putting aside the political rhetoric, everyone realizes that more economic growth and a greater increase in net jobs is needed.

The Ugly

The ugly award goes to the rather surprising result of diversification into commodities. Tom Brakke always combines clear-headed analysis with great charts. He analyzes the concepts behind the chart below. Check out the full discussion, but this point describes investor behavior: "Investors have embraced these alternatives, only to find that they don’t
really know much about them other than they’re not stocks or bonds."

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The SLFSI reports with a one-week lag. This means that the
reported values do not include
last week's market action. The SLFSI
has moved a lot lower, and is now out of the
trigger range of my pre-determined
risk alarm. This is an excellent tool for
managing risk objectively, and it has
suggested the need for more caution. Before
implementing this indicator our team did
extensive research, discovering a "warning
range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool,
since it does not attempt to predict how people will interpret
events. It uses data, mostly from credit markets, to reach an
objective risk assessment. The biggest profits come from
going all-in when risk is high on this indicator, but so do
the biggest losses.

Bob and I recently did some videos explaining the recession
history. I am working on a post that will show how to use this method.
As I have written for many months, there is no imminent recession
concern. I recently showed the significance of by explaining the relationship to the business cycle.

The evidence against the ECRI recession forecast continues to mount.
It is disappointing that those with the best forecasting records get
so much less media attention. The idea that a recession has already
started is losing credibility with most observers. I urge readers to
check out the list of excellent updates from prior posts.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

The single best resource for the ECRI call and the ongoing debate is Doug Short. This week's articledescribes
the complete history, the critics, and how it has played out. The
article highlights the most important economic indicators used in
identifying recessions, showing that none have rolled over. Doug updates the recession debate every week and includes a great chart of the "big four" indicators used by the NBER in recession dating.

Meanwhile, the ECRI story continues to change. The latest variation is that the data will eventually be revised lower to show that we are already in recession.

Note on the Fiscal Cliff -- A thoughtful reader asks whether our recession forecasts include the fiscal cliff, a good question. Methods derived from historical experience are not helpful on issues like the cliff, so the general answer is "no," but some of the market-based methods will capture this as the time comes closer. I treat factors like the fiscal cliff, the collapse of Europe, the collapse of China, an attack on Iran, and similar factors as relevant elements of "tail risk." There is no good way to incorporate these into standard recession forecasting methods, so no one even tries. (I am ignoring those with a semi-permanent recession forecast!)

I frequently cite and monitor these factors in the weekly commentary, especially in "the ugly" section. If you insist on waiting for a time when there are no low-probability risks, you are a spectator, not an investor.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll.
We have a long public record for these
positions. This week we continued with our recent switch to neutral. We have been
bullish since June 23rd, with a one-week move to neutral a month
ago. These are one-month forecasts for the poll, but Felix has a
three-week horizon. The ratings have moved lower, and the confidence has deteriorated from last week.

[For more on the penalty box see this article.
For more on the system
ratings, you can write to etf at newarc
dot com for our free report package or to
be added to the (free) weekly ETF
email list. You can also write
personally to me with questions or
comments, and I'll do my best to answer.]

The Week Ahead

There is plenty of data coming this week, but two events loom large:

The German Constitutional Court ruling (W, before US markets open). The feeling is that the Court will accept an increased German role -- -perhaps 80%. If not, there will be a scramble to figure out what portion of current plans may still be feasible.

The FOMC announcement and Bernanke's press conference (Th afternoon)

The "A List" includes the following:

Trade balance (T) with implications for GDP.

Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy.

The "B List" includes several reports:

Industrial production (F).

Michigan consumer sentiment (F) which has implications for consumer spending and employment.

PPI (Th) and CPI (F) are sometimes important, but only if we get a few scary reports. That would create a dilemma for the Fed.

The time from the market opening on Wednesday through the FOMC announcement on Thursday will be the most crucial hours of the week.

Trading Time Frame

Despite Felix's overall "neutral" posture, our trading positions continued in fully invested mode last week.
Felix became more aggressive in a timely fashion, near the start of the
summer rally. Since we only require three buyable sectors, the
trading accounts look for the "bull market somewhere" even when the
overall picture is neutral. The ratings have been getting a little weaker, but the trade continues to be profitable.

Felix does not try to call tops and bottoms, but instead keeps us on the
right side of major moves, either up or down.

Investor Time Frame

Long-term investing is an objective for many of my clients, so I give it a lot of thought. Each week I try to provide an idea or two that will be useful for those sharing this perspective. Here are two new ones.

How much risk to take. The right answer is different for everyone, but too many people choose "zero." These investors do not follow the Buffett advice of buying when others are fearful. Then, when the market rallies, they are afraid that they are "too late." I wrote a new article, Stock Prices and the Fundamentals: Don't be Fooled, showing how to avoid this trap.

How to pick dividend stocks. Regular readers know that I am fussy about my choice of dividend stocks and I like to enhance yield by selling near-term calls against the position. Carla Pasternak explains why it is important to look beyond the yield, finding companies that also represent good value. This is a fine article, combining both a great approach with some specific ideas.

If you have been following our regular advice, you have done the following:

Replaced your bond mutual funds with individual bonds;

Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and

Added some octane with a reasonable allocation of good stocks.

There is nothing more satisfying than collecting good returns in a sideways market.

If you have not done so, it is certainly not too late. We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments welcome!)

Final Thoughts on the Fed

Before this week I was not expecting an aggressive action by the Fed, but my own opinion changes with the data.

The mistake made by most is a collection of dangerous ideas -- OK for politics, but risky for trading and investing. In the absence of a better term, I'm going to call it the Fed Skeptic Syndrome.

The Fed Skeptic has the following collection of beliefs:

QE has no positive economic effect. It has not helped employment and has boosted stocks only because the Fed bond buys act like direct purchases of stocks and commodities -- in addition to pushing conservative savers into tech stocks and soybeans. Fed action has artificially kept stock prices and the economy higher, but is ineffective. You can see this because things are worse than they were a few years ago. It is all a sugar high, and it will end badly either through deflation, or hyperinflation, or both. These forecasts are certified by an array of "chief investment strategists" whose credentials do not include economic education but do include frequent media appearances. The most popular are "self-taught in Austrian economics."

The FOMC has the opposite viewpoint:

QE has lowered interest rates by a few bps and generated a gain of about 2 million jobs over what otherwise would have happened. There was no direct effect on commodity prices. Misguided speculators drove these prices higher. Stock price increases reflected the improved economic prospects from the program, and also created a virtuous cycle of confidence and wealth effects. The proponents are all credentialed mainstream economists of both political parties.

As a voter, feel free to take whatever perspective you want.

As an investor, it is wise to understand those who actually have power, and predict what they will do. Most of those who are missing the rally do not have sufficient respect for the determination and power of government officials.

August 18, 2012

The official calendar is pretty quiet. Earnings season is over. Politicians are on vacation in the US and European leaders are just returning.

Beginning with the annual Kansas City Fed gathering at Jackson Hole and proceeding through a series of meetings in Europe, and the US political conventions, we will have a flurry of activity by key policymakers. Calculated Risk has a nice, long-term calendar of these events.

Here are the questions that could have the biggest market effects:

Will the Fed initiate another round of QE at the September meeting?

Will European leaders (including various institutions like the German Supreme Court) take more aggressive action to help the periphery countries?

How might the US election affect stocks and specific market sectors?

I'll offer some of my own expectations in the conclusion, but first let us do our regular review of last week's news.

Background on "Weighing the Week Ahead"

There are many good sources for a list of upcoming events. With foreign markets setting the tone for US trading on many days, I especially like the comprehensive calendar from Forexpros. There is also helpful descriptive and historical information on each item.

In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.

It is better than expectations.

The Good

There was quite a bit of economic data last week, and it had a generally positive tone.

Building permits are very strong. This is important, since a rebound in housing would really help the economy after a multi-year drag. Steven Hansen has a good analysis.

Inflation data remained tame. The CPI charts are not very interesting, and the Fed expects to be on hold for years. I prefer to look at Doug Short's CPI components. This will help us predict future Fed actions.

Leading Economic indicators from the Conference Board turned nicely higher.

Retail sales spiked higher. This is good news and important since it is the only one of the major recession indicators that has turned lower in recent months. We still need more data to have real confidence. Shortly after the announcement, the typical bogus story made the rounds: The entire gain was the result of fictitious seasonal adjustments, out of line with anything from the last ten years.

[rant on]

I have tried to explain the pernicious effect of sources that have no clue about data analysis -- no one who has actually done a seasonal adjustment. The story often starts with a site that is bigger than any of the reputable bloggers -- bigger than Barry or Calculated Risk. The story is immediately repeated on dozens of other sites. It is repeated on CNBC.

There is a huge market for fear and conspiracy. Each week I get reader inquiries about some bogus chart, but I cannot be a one-man truth squad. There is only one of me, and there are many Tyler Durdens!

On this particular topic, there is an obvious answer. Retail sales are seasonally adjusted for the number of weekends. It is just what you and I would do if we looked at a long data history, since weekends make a difference. July 2012 had only four weekends instead of five. Also the 4th of July was mid-week, affecting travel and other factors. The conspiracy site chopped off their analysis at ten years. If one of the several Tyler Durdens had wanted to be honest, he would have looked back two more years, where there were 4 1/2 weekend days and mid-week holidays. It takes very little effort to be honest, but apparently that is not the way to become the leading financial blog, so they chop their analysis without including the relevant years.

Also, you should note that seasonal adjustments net to zero over the course of a year. Why doesn't Tyler ever highlight the times the adjustments suggest better data?

And finally, there is no conspiracy. Government statisticians cannot change the procedures in a heartbeat to make things look better. Sheesh! This is so aggravating. So many people are being duped -- including those who should know better. This stuff is repeated via email, mostly because it fits the bearish pre-disposition.

[rant off]

The Bad

The was a little negative news.

Gasoline prices moved higher, up another seven cents and higher than a year ago (via Bonddad, with other high frequency indicators as well). This implies less discretionary spending for the average consumer.

The earnings beat rate drifted south as did that for revenues. Bespoke has the story and great charts. I am showing the revenue chart, which reflects Europe effects. We should all note that part of the reason that revenue is worse than earnings it the currency effect. Companies with significant foreign revenues also have lower costs. Scott Rothbort, who writes a great daily column at Wall Street All Stars (subscription required, but I have some discounts available so write me if interested), noted this effect, which seems to have eluded the general punditry.

Facebook after the lockup (preventing insider sales) expired Bad for those who bought the IPO and also for individual investor confidence. Abnormal Returns had a great post exploring the nuances of this experience. Everyone appreciates the daily links from AR, but when Tadas has the time for this type of story, it is especially helpful. Bespoke has a dramatic chart, comparing to Google at the IPO stage.

The drought. Some readers have taken me up on my invitation to comment, wondering why I have not featured this bad news. I agree that the drought is bad on many fronts. The problem in fitting it into my weekly series is "when?" We have a short-term focus. But I agree. Barry Ritholtz has an excellent post with great charts. Take a look.

Regional Fed surveys were poor. I do not regard these as very important, but I do emphasize the ISM survey. Calculated Risk explains why I should pay attention -- a good correlation.

There may be real demographic limits on GDP growth -- demographics and productivity. Kate Mackenzie at the FT has a fine article explaining this problem.

While many readers enjoyed the approach, many others did not read past the headline and the first few paragraphs. Humor and irony are difficult to achieve online. After seeing the reaction, I was reminded of Doug Kass's April Fools joke in 2008. At the time he had been pretty bearish, but he flipped bullish in the joke article. The story was actually picked up by clueless editors at major news sources.

If you look at my story, please keep in mind that I am trying to illustrate a point on statistical inference, not something about politics!

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

Bob and I did some videos last week explaining the recession history. I am working on a post that will show how to use this method. As I have written for many months, there is no imminent recession concern.

The evidence against the ECRI recession forecast continues to mount. It is disappointing that those with the best forecasting records get so much less media attention. The idea that a recession has already started is losing credibility with most observers. I urge readers to check out the list of excellent updates from prior posts.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. This week we continued as bullish. We have been bullish since June 23rd, with a one-week move to neutral a few weeks ago. These are one-month forecasts for the poll, but Felix has a three-week horizon. The ratings are higher, and the confidence is improving.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

There is not much to look for in terms of economic data this week.

The big item will be initial jobless claims on Thursday.

Housing data include existing and new home sales on Wednesday and Thursday. We also get the FHFA home price report, although this gets less attention than the competing measures. Friday brings the durable goods report.

There will be Fed news, with speeches by two regional bank presidents (Lockhart and Evans) on Tuesday and Wednesday, and the FOMC minutes on Wednesday. There has been some market reaction to various Fed commentary in recent weeks, mostly for hints of another round of QE.

Angela Merkel, mostly late in the week, will have meetings with leaders from Greece, France, and the head of the eurozone finance ministers. Nothing definite will be decided, but everyone is interested in the German position toward both bailouts and ECB bond purchases.

I am expecting a quiet week, but with so much interest in Fed and European policy, expect pundits to pounce on any hints.

Trading Time Frame

Our trading positions continued in fully invested mode last week. Felix became more aggressive in a timely fashion, near the start of the recent rally. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. As the tape has improved, the ratings from Felix have gotten stronger.

Felix does not try to call tops and bottoms, but keeps us on the right side of major moves.

Investor Time Frame

A problem with market timing is the wide variety of methods with varying conclusions. This week I saw an interesting and unusual contrast.

Morgan Stanley's Adam Parker is sticking with his forecast for the S&P 500 to close the year at 1167, a decline of nearly 18% before the end of the year.

Georg Vrba, whose excellent work on recession forecasting has helped our readers, has two different market-timing methods. His most recent article explains that the next great bull market might already be here.

The interesting contrast is that Parker uses forward earnings and Vrba uses backward-looking Shiller data! You should read both articles to see the rationale.

Which of them is right? A great deal depends upon what is already anticipated by the markets. The average investor reads the financial news and thinks that gives him an edge. That only tells him what everyone else knows and is worried about.

In short, if you don't know that the world is beset with problems and threats of mega proportions, then you just haven't been paying attention. And if you have been paying attention, you're extremely worried about all the things that could wrong, and it's a good bet that your portfolio is extremely conservative. The charts above tell the story: for the past three years, investors have been pulling money out of equity funds and stuffing it into the relatively safety of bond funds, despite the ongoing rise in equity prices. Markets everywhere are depressed because of all the concerns over all the things that might go wrong. Forecasts for future growth range from a depression to, at best, 2.5-3% real growth. Contrarians take note: no one is forecasting growth in excess of 3-4%.

If you have been following our regular advice, you have done the following:

Replaced your bond mutual funds with individual bonds;

Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and

Added some octane with a reasonable input of good stocks.

There is nothing more satisfying than collecting good returns in a sideways market.

If you have not done so, it is certainly not too late. We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments welcome!)

Final Thoughts on the Lull and the Storm

Here are a few fearless forecasts.

The Fed will act, but not another round of quantitative easing. They might link action to actual lending by member banks and/or quit paying interest on reserves. The problem is increasing the money supply, so that might be the focus.

Europe will continue the incremental progress toward the final solution, a patchwork compromise that is not a plan. It will be the result of a process. The epiphany for investors will come when it is too late for most.

Nothing in the political campaign will be helpful for markets. The fiscal cliff will be with us until after the election, as will the resulting anticipation and fear.

August 13, 2012

In the entire history of official recession dating (beginning in the 1850's) there is a startling fact:

Every newly-elected Republican President has brought a first-term recession. All of them. "Always and only" as we hear from a popular data-mining pundit.

You can check out the list of GOP Presidents here. And the official recession dating here. I use "elected" because there was no recession in the brief term of fellow Michigan man Gerald Ford.

It is not quite "only" since Democratic Presidents avoided recessions on a 10-2 basis. I am not surprised that there was no first-term recession for Bill Clinton or JFK, but who would have expected a clean record for FDR or Jimmy Carter?

Here is another study that says Democrats win on a balance of economic indicators, 11-2. The authors conclude as follows:

"President Barack Obama does not feature in the rankings, as he has not yet completed a four-year term. But if Obama were evaluated now on all 12 of the indicators, he would fall somewhere in the middle of the pack, Deitrick says. The bottom of the pack overall is populated by Republicans: Presidents Richard Nixon, Gerald Ford, George W. Bush and Herbert Hoover."

Lessons in Inference

I trust that readers will understand my tongue-in-cheek approach to this subject. It is silly to conclude, based on this evidence, that electing Romney will lead to a recession.

Meanwhile, many people use similar evidence to make bold claims about recessions. Their readers consume the pseudo-scientific claptrap and blindly follow the pundit to a dubious decision.

If you agree with me that the conclusion about Romney is not valid, then maybe you need to reconsider the work of the guy who keeps describing a syndrome involving his Aunt Gertrude. The methodology -- using many years of backfitted data -- is just the same as you see here.

Causal Modeling

Causal reasoning in economics involves many variables. Especially when the number of cases is relatively small and the number of variables is large, the causal model can be tricky.

Try this one: When a Republican is elected, it is often the result of Democratic economic failures. This means that the GOP winner is saddled with a bad economy.

See how easy it is to create reasons after the fact? Check out one of my favorite stories from "the old days." The smarter you are, the easier it is to fool yourself.

Investment Conclusion

If you understand this article, you can win an Olympic all-around medal!

Separate politics from your investments;

Ignore bogus pseudo-science;

Beware of recent trends in both fear and greed;

Look for stocks with attractive valuations.

Each week I summarize the very best recession forecasts. Since those with the best records are not featured in the financial media, this gives thoughtful readers an advantage. Those scared witless by the recessionistas are selling cyclical names and tech stocks while piling into defensive sectors and dividend stocks.

The comparative valuations are becoming extreme. I favor early-stage cyclicals like Caterpillar, Cummings, and Illinois Tool Works. I like tech stocks including Apple, Oracle, Microsoft, and Marvel.

When I look for "dividend stocks" I am not seeking those with super-high yields, but strong balance sheets and PEG ratios, where I can also sell calls to enhance the yield.

The individual investor can find many good opportunities, but you must start with a good grasp of the business cycle.

(HT to Bob Dieli, whose whimsical comment inspired this post. And no, the election result is not one of the factors in his excellent system, Mr. Model.)

July 05, 2012

We rely too much on the monthly employment outlook report. It is a natural mistake. We all want to know whether the economy is improving and, if so, by how much. Employment is the key metric since it is fundamental for consumption, corporate profits, tax revenues, deficit reduction, and financial markets.

Since the subject is so important, most people place too much emphasis on the official (preliminary) report, which is really only an estimate. In about eight months, we'll have an accurate count from state employment offices, but by then no one will care.

There are several competing methods that provide independent approaches to analyzing employment.

I will first summarize the BLS official methodology. Next I will review alternative approaches and those forecasts. I will conclude with some ideas about what to watch for.

The Data

We would like to know the net addition of jobs in the month of May.

To provide an estimate of monthly job changes the BLS has a complex methodology that includes the following steps:

An initial report of a survey of establishments. Even if the survey sample was perfect (and we all know that it is not) and the response rate was 100% (which it is not) the sampling error alone for a 90% confidence interval is +/- 100K jobs.

The report is revised to reflect additional responses over the next two months.

There is an adjustment to account for job creation -- much maligned and misunderstood by nearly everyone.

The final data are benchmarked against the state employment data every year. This usually shows that the overall process was very good, but it led to major downward adjustments at the time of the recession. More recently, the BLS estimates have been too low. (See here for a more detailed account of this, along with supporting data).

Competing Estimates

The BLS report is really an initial estimate, not the ultimate answer. What we are all looking for is information about job growth. There are several competing sources using different methods and with different answers.

ADP has actual, real-time data from firms that use their services. The firms are not completely representative of the entire universe, but it is a different and interesting source. ADP reports gains of 176K private jobs on a seasonally adjusted basis. In general, the ADP results correlate well with the final data from the BLS, but not always the initial estimate.

Economic correlations. Most Wall Street economists use a method that employs data from various inputs, sometimes including ADP (which I think is cheating -- you should make an independent estimate).

Jeff Method. I use the four-week moving average of initial claims, the ISM manufacturing index, and the University of Michigan sentiment index. I do this to embrace both job creation (running at over 2.3 million jobs per month) and job destruction (running at about 2.1 million jobs per month). In mid-2011 the sentiment index started reflecting gas prices and the debt ceiling debate rather than broader concerns. When you know there is a problem with an input variable, you need to review the model. For the moment, the Jeff model is on the sidelines. From my perspective, the decline in consumer confidence, even with lower gas prices, is disturbing. It is difficult to account for the effect of headlines about Europe and the fiscal cliff.

Street estimates generally follow my method, but few reveal much about the specific approach. Have a little fun by looking at the specific forecasts from many firms, along with a picture of the spokesperson! Thanks to Business Insider. Joe Weisenthal, in a good story about Goldman, notes that some of these estimates are already responding to the ADP report.

Gallup sees unemployment as falling on a seasonally adjusted basis (but flat if unadjusted). This is interesting since they have a different survey from the government, a relatively new approach to seasonal adjustment, and an extremely bearish and political approach in past commentaries. Gallup's methods deserve respect, so I am watching closely.

Partial Indicators

A problem with forecasting net employment changes is that you need to look at all of the following:

Both hiring and firing;

Companies of all sizes; and

Failing companies and new businesses.

There are many interesting pieces to the puzzle, but it is easy to over-react without the context listed above. The respected Challenger survey reports fewer layoffs. Excellent! But does that mean hiring? Initial jobless claims move higher. That tells us about job losses at certain types of firms, but nothing about job creation.

An interesting idea comes from Michael Mandel, who astutely notes the disparity in help-wanted ads according to the occupation. Harkening back to The Graduate, Michael (one of my favorite acquaintances from my Kauffman meetings), writes as follows:

"If you have a college student in your family who is looking for a job, remember this one word: 'Data.'"

For Dustin Hoffman it was "plastics." Michael says to watch this, so I am and you should, too.

Men on a Mission

(And women too, of course, but I could not resist the alliteration. Biased female economists should feel free to accept equal blame!)

Here at "A Dash" we have great respect for those who make objective, independent forecasts. We know that methods may lead to different conclusions, and that debate is healthy.

With this in mind, here are two examples:

TrimTabs confidently asserts that the BLS data will be wrong! Amazing, without knowing the content of the report or the revisions. They assert that we are in a "depression" and are confident about the direction of later revisions. While I have been sympathetic to their own mistakes, and agree about revisions, they do not seem to realize that the BLS has been understating growth for a couple of years. Why the agenda?

David Rosenberg is out with a list of reasons why the jobs report will "stink." He cites a number of interesting indicators. A serious economist would do research with a time series on each, discarding those that reflected multi-collinearity. That is what my team did. He cherry picks reports and plays the same tune, always finding new data. He has an audience, and one much bigger than mine! [Will someone please remind me of who first said that the crowd expects Neil Diamond to sing Sweet Caroline? I want to give credit where it is due.]

Failures of Understanding

There is a list of repeated monthly mistakes by the assembled jobs punditry:

Focus on net job creation. This is the most important. The big story is the teeming stew of job gains and losses. It is never mentioned on employment Friday. The US economy creates over 7 million jobs every quarter.

Failure to recognize sampling error. The payroll number has a confidence interval of +/- 105K jobs. The household survey is +/- 450K jobs. We take small deviations from expectations too seriously -- far too seriously.

False emphasis on "the internals." Pundits pontificate on various sub-categories of the report, assuming laser-like accuracy. In fact, the sampling error (not to mention revisions and non-sampling error) in these categories is huge.

Negative spin on the BLS methods. There is a routine monthly question about how many payroll jobs were added by the BLS birth/death adjustment. This is a propaganda war that seems to have ended years ago with a huge bearish spin. For anyone who really wants to know, the BLS methods have been under-estimating new job creation. This was demonstrated in the latest benchmark revisions, which added more jobs, as well as the most recent report from state employment offices.

It would be a refreshing change if your top news sources featured any of these ideas, but don't hold your breath!

Trading Implications

My experience with employment Fridays is that there is little benefit to being aggressively long before the report. The spinfest usually provides shorts with a morning "dip to cover" when the number is surprisingly good.

I also expect some dampening in either direction. A really bad number will be met with expectations for Fed action. A strong number will get the opposite result, and maybe a stronger dollar.

Unless there is a massive discrepancy from expectations, my guess is that we will move on to earnings season and option volatility will be reduced.

And most important.....investors should not let this become political, even though the pundits will.